The reaction to Fed Chair Powell’s comments was clear. Traders had expected more definitive rhetoric, guiding us to a clear path that ultimately led to an ‘insurance’ or ‘maintenance’ rate cut - what we heard failed to shine any light on this thesis. Throw in comments that “some or all” of the weakness in core inflation is transitory, and we have a market that was just not ready to hear Powell distance himself from the recent commentary from other Fed members, such as Evans, Clarida, Rosengren and Kaplan.
Ok, we saw a cut of 5bp on the level of interest certain financial institutes can earn from parking excess reserves with the Fed, and that is important. Here, the Fed is again faced with installing full confidence that they have full control on the price of money, as we are talking about the plumbing in the US financial system and that sits right at the top of the food chain and above all other considerations. However, the bigger influence for markets, at this juncture, is the belief that the man at the helm of the Fed is prepared to tolerate low inflation. So, if we mark-to-market the dovish views around the expected trajectory of Fed funds rate, relative to Powell’s narrative, then it’s clear to see why we have seen some fairly punchy moves in adjustment.
Now, Powell’s view will change as the economy evolves, and he will have Q418 firmly in his mind when he was schooled by the sheer ferocity of how markets react if the Fed’s message on future policy is sufficiently different from that of what the markets believe is correct. And, we may well look back in 12-months’ time and give credit to Mr Powell for his glass-half-full view on core inflation. But, if inflation doesn’t head higher, how long do we give before cries for the Fed to stimulate are heard more clearly? I'd say three months at most, although we keep our eyes on market-based inflation reads, such as the US 5-year forward swap, as well as financial conditions indices - so, if these show a more worrying trend, then the bar is sufficiently low enough for an insurance cut.
The daily chart of the S&P 500 needs close attention, as we saw a bearish outside day reversal (i.e. price opened and traded above Wednesday high, before closing firmly below Wednesday low) at the all-time high, while also rejecting trend resistance.
These reversal patterns need to confirm, and therefore the overnight session low of 2923.36 has to hold or equities likely head lower. We’ve already seen S&P 500 implied volatility heading towards 15%, as traders pay up for what was cheap portfolio hedges. By way of example, we can look at the implied volatility in S&P 500 puts at 2780 (i.e. 5% away from the market) and see this moving nicely above 16% as demand for downside protection ramped up. If vols go higher, then cash levels in portfolios will rise, and this will only compound the issue.
So, inflation is seen as transitory, but its clear the market is incredibly worried to think inflation could rise, reducing dovish rates pricing and pushing ‘real’ yields higher. As these varaibles have been key reasoning why the S&P, Nasdaq and Dow are all where they are - if this dynamic is threatened then equities trade lower. So, we ask ourselves was this Fed meet sufficient to cause a lasting effect on rates and yields – I am unconvinced.
At this stage in Asia, S&P 500 and Nasdaq futures are stable, while we have Hong Kong 0.6% higher and Nikkei futures are finding buyers, while the ASX 200 (-0.6%) and China are lower on the day. Aussie banks are giving back nearly all the 1.5% gain we saw yesterday. Volumes through the ASX 200 are about 10% above average, but breadth is neutral with 53% of stocks lower on the day. There is no bid in the bond market, with Aussie 10-year Treasury +1bp at 1.78% and Asia based traders are not finding solace in the JPY, although I am looking very closely at SEKJPY and ready to pull the trigger on shorts on a clear move through 11.66. Keep an eye on US crude too, as price feels heavy here and -0.3% on the day with traders still focused on the massive 9.9m barrel build on the overnight DoE inventory report.
Elsewhere in G10 FX, its tight ranges seen, and flow has been quite calm with a view this may ramp up into European trade. EURUSD oscillates around the 1.12 handle, although traders will be closely watching bond moves in the session ahead to get direction, not to mention equity and volatility reads. With a number of Fed speakers due to speak at the Hoover Institute on Friday, married at the same time as payrolls and services ISM and European inflation, it feels like there is perhaps some life brewing in these here markets.